China's trade patterns are evolving. While it started in light manufacturing and the assembly of more sophisticated products as part of global supply chains, China is now moving up the value chain, 'onshoring' the production of higher-value-added upstream products and moving into more sophisticated downstream products as well. At the same time, with its wages rising, it has started to exit some lower-end, more labor-intensive sectors. These changes are taking place in the broader context of China's rebalancing-away from exports and toward domestic demand, and within the latter, away from investment and toward consumption-and as a consequence, demand for some commodity imports is slowing, while consumption imports are slowly rising. The evolution of Chinese trade, investment, and consumption patterns offers opportunities and challenges to low-wage, low-income countries, including China's neighbors in the Mekong region. Cambodia, Lao P.D.R., Myanmar, and Vietnam (the CLMV) are all open economies that are highly integrated with China. Rebalancing in China may mean less of a role for commodity exports from the region, but at the same time, the CLMV's low labor costs suggest that manufacturing assembly for export could take off as China becomes less competitive, and as China itself demands more consumption items. Labor costs, however, are only part of the story. The CLMV will need to strengthen their infrastructure, education, governance, and trade regimes, and also run sound macro policies in order to capitalize fully on the opportunities presented by China's transformation. With such policy efforts, the CLMV could see their trade and integration with global supply chains grow dramatically in the coming years.

Cambodia

Cambodia has become one of the world’s fastest-growing frontier economies. Growth averaged nearly 8 percent during the past two decades, and GNI per capita quadrupled during this period, reaching US $1,010 in 2014, and the country should soon achieve middle-income status. The economy is highly open and dependent on exports to the European Union and the United States, as well as on foreign direct investment (mostly from China). Nonetheless, this growth relies on a narrow economic base of garment exports and tourism, and Cambodia is exposed to external shocks, particularly as key materials for production, such as fabric, are imported.25 Garments—growing by an average of 12½ percent during the past five years, and accounting for more than three-quarters of total exports—benefits from low wages and preferential market access to the European Union. Recent FDI trends point to early signs of diversification into other manufacturing products including electronics, as regional producers attempt to diversify their supply chain.

Cambodia’s economy is closely linked to China’s. China is the principal source of fabric imports into Cambodia, and trade between the two countries rose eightfold between 2000 and 2013.26 By 2013, almost one-third of Cambodia’s imports, valued at US$3.7 billion, came from China. Chinese tourist arrivals also continue to grow strongly, with China now the second largest source of tourists. China is Cambodia’s largest source of FDI, having invested a total of US$1.4 billion by 2012 or 19 percent of the total FDI (10 percent of GDP),27 mostly in garments, tourism, agriculture, power plants, and mining. Finally, China remains Cambodia’s biggest source of official loans, accounting for $2.4 billion or 43 percent of the total debt stock and about 90 percent of bilateral debt disbursement during 2012–14. Cambodia has been using these funds to build roads and bridges, helping to improve its infrastructure.

Cambodia’s garment industry is dominated by foreign-owned firms, the majority of which are from China, Taiwan Province of China, and Hong Kong SAR. Production, export, and management decisions are mostly made at the headquarters of the parent companies, which are likely to be transnational manufacturing companies sourcing to global buyers. The link with international buyers has provided Cambodia’s garments industry an important link into the global value chain, which has contributed to growth and employment over the past two decades.

The competitiveness of Cambodia’s garments industry remains weak and is driven largely by the preferential access to key markets. The local textiles industry is non-existent and hence there is a high import dependence on inputs, mainly from China, subjecting Cambodia to volatile input prices. High transportation and electricity costs have resulted in overall higher cost despite lower wages relative to its peers. Furthermore, though wages are low, labor productivity also is low,28 reducing Cambodia’s overall competitiveness.

This reliance on a narrow production and export base has many downsides. A majority of Cambodian garment factories concentrate on cut-make-trim processes, which are at the bottom of the value chain and also a small part of the overall production. As a result, firms in Cambodia have limited leverage and autonomy in terms of strategic decisions. These companies tend to have many other subsidiaries around the globe with substitutable products and are less likely to invest in upgrading capacity in Cambodia.

In the near term, Cambodia’s garment sector needs to accelerate diversifying its export destinations to mitigate concentration risks. Productivity improvement, such as reducing production lead times, is crucial to maintaining competitiveness and capturing opportunities to further participate in value chains via upgrading in products, processes, and functions.

Appendix Figure 1.Total FDI Stock from China to Cambodia

Lao P.D.R.

Lao P.D.R. was one of the most dynamic frontier economies in the past decade, but its narrow economic base constitutes an important vulnerability. Despite weaker global growth and external uncertainties, real GDP grew at an average of about 8 percent in the past decade, driven by investments in hydropower, infrastructure, real estate construction, and increasingly, domestic consumption. Mining production rose significantly from the operation of new gold, copper, and silver mines and the expansion of existing minerals projects. As a result, per capita income doubled to about US$2,900 in purchasing power parity terms and the poverty rate fell from about 33 percent in 2002/3 to 22 percent in 2012/13. The government remains committed to achieving middle-income country status by 2020, but has lowered its medium-term growth target to 7.5 percent per year, citing the need for better-quality growth with macroeconomic stability. Growth remains largely driven by FDI inflows into resource and construction sectors.

China’s economic ties with Lao P.D.R. have increased dramatically in recent years. In 2013, China became the biggest foreign investor in Lao P.D.R., with a cumulative stock of US$5.4 billion, edging out Thailand and Vietnam. This number corresponds to about a third of total investments in the country, including in agriculture, electricity, mining, and services. The Lao government has also announced a plan to build a controversial railroad linking China’s Yunnan Province to the Lao capital of Vientiane, and then to Thailand, at a cost of US$6 billion, equivalent to 50 percent of the Lao GDP. China will finance the majority of the investment (about 70 percent) and extend loans to the Lao P.D.R. government to finance its equity share.

Bilateral trade between Lao P.D.R. and China has skyrocketed in the past five years, making China Lao P.D.R.’s biggest trade partner. From 2008 to 2014, China’s share in Lao P.D.R. imports increased from 8 to 26 percent. Similarly, Lao P.D.R.’s exports to China increased eightfold, with China’s share growing from 10 percent to 35 percent.

Lao P.D.R.’s largest stock of official bilateral debt is with China, and China’s financing role has increased rapidly in the past five years. China’s official loans to Lao P.D.R. have risen from about 25 percent of all bilateral debt in 2008 to about 50 percent in 2013. This is equivalent to 26 percent of Lao P.D.R.’s total external debt. These official loans have financed a large part of the government’s capital expenditures, concentrated mostly in hydropower plants and other large infrastructure projects.

Recent efforts to promote economic diversification, such as agreements to facilitate trade, are commendable. Fifteen years after it first sought membership, Lao P.D.R. became the 158th member of the World Trade Organization (WTO) in February 2013. Accession to the WTO provides Lao P.D.R. with more market opportunities to diversify trading partners, realize gains from trade, and enhance investor confidence. As part of the process, Lao P.D.R. opened its economy to foreign access in several sectors, the most important being services. Progress was also achieved on structural reforms as the national assembly enacted more than 90 laws and regulations, including those related to import licensing, custom valuation, investment, sanitary and phytosanitary measures, technical barriers to trade, and intellectual property rights, in order to better align its laws and regulations with international norms.

Recent reforms to improve the business climate also seek to promote economic activity in the nonresource sector. Some of these measures include (1) efforts to simplify business startup procedures, notably with the establishment of a one-stop shop to coordinate the application for foreign investment; (2) modernizing electronic data interchange systems to better facilitate cross-border trade; and (3) establishing the Lao trade portal to facilitate international trade and enhance transparency of transactions. The authorities believe that these initiatives will help create a more favorable business climate conducive to broad-based and inclusive growth.

While labor productivity remains low in Lao P.D.R. compared with higher-income ASEAN neighbors, productivity growth is among the highest in the region. This reflects good progress over many years in opening product and labor markets, and improving health and education. Finance, real estate, business services, transport and communication, and construction are leading contributors to productivity growth. Maintaining growth in productivity, however, will require further investments, particularly in education, infrastructure, and institutional reform.

Myanmar

Myanmar is rapidly emerging from a long period of isolation. The government is pursuing comprehensive economic reforms to open the country to the global economy, boost growth, and reduce poverty. Since economic liberalization in 2011, economic growth has been accelerating, led by gas production, construction, tourism, and manufacturing, and reached almost 8½ percent in 2013/14.

Myanmar faces important development challenges, but it has significant economic potential. Living standards in Myanmar remain among the lowest in the region, as measured by per capita GDP (PPP), while social well-being, measured by the Human Development Index, is also much lower than that in regional peers (ranked 149 out of a total 186 countries). However, the country has a young and large labor force, low wages, and a strategic geographic location, which could facilitate entry into Asian supply chains. To take advantage of these conditions, Myanmar needs to push forward with reforms to raise productivity, including through improvements in business environment and infrastructure.

Myanmar is not as open to trade as it neighbors, but trade is growing. Partly reflecting economic sanctions by traditional development partners, the country’s trade openness ratio (ratio of exports plus imports to GDP) has been much lower than that of most other Asian countries. Exports are also highly concentrated, in terms of both products and trading partners, and that concentration is increasing as a result of rising natural gas exports. Historically, foodstuffs—primarily pulses and rice—and nonfuel crude materials—mostly teak and other hardwoods—were Myanmar’s main export earners. The garments industry developed rapidly and by the early 2000s, had become a significant export sector for the country, but since then, mineral fuels have taken the top slot. On the import side, the composition has been rather stable, with manufactured goods, including machinery and transport equipment, accounting for the bulk of imports. Overall, trade is growing rapidly—indeed the fastest among the CLMV (albeit from a low base).

China has emerged as the largest trade partner both in exports and imports, mainly through cross-border trade. China is now a major supplier of consumer and capital goods to Myanmar, while Myanmar supplies timber and natural gas to China. Border trade represents the lion’s share of the bilateral trade, in both directions. Myanmar and China also have considerable economic cooperation in the areas of infrastructure and energy involving state-owned enterprises.

Myanmar continues to face significant challenges, but the authorities have embarked on a comprehensive reform path. In 2013, they introduced their Framework for Economic and Social Reforms, a long-term strategy for achieving sustainable economic growth and reducing poverty. If implemented as planned, sustained and stable growth should be possible over the mid-to-longer term. Regional integration could also help, including through the ongoing establishment of the ASEAN Economic Community.

Appendix Figure 2.Per Capita GDP (PPP)

Source: IMF, World Economic Outlook.

Appendix Figure 3.Human Development Index, 2012

Sources: Human Development Reports, United Nations Development Programme.

Vietnam

Growth averaged over 7 percent in the years before the global financial crisis. This was led mainly by increasingly intensive agricultural production, rapidly expanding state-owned enterprise (SOE) investment, financial services, and labor-intensive manufacturing driven by foreign direct investment. The global financial crisis laid bare the weaknesses of the state-led growth model based on expanding inefficient public and SOE investment, which eventually led to a slowdown in growth, high inflation, a weakening currency, large trade deficits, and dwindling foreign exchange reserves.

The external sector has been the driver of growth in recent years, while the domestic economy has been burdened by slow progress with SOE and banking sector reform. The authorities succeeded in stabilizing the economy from 2011 onward, but growth remained below crisis levels at an annual average of 5¾ percent. The economy faces structural challenges that create a headwind for growth (SOE reform, banking sector weakness, and diminishing fiscal space for bank and SOE restructuring costs and countercyclical policies). FDI manufactured exports have been a bright spot. Production has increasingly moved toward more sophisticated products, from commodities and garments to computer components, cell phones, and other electronic components.

Today, Vietnam is a very open economy, exporting a broad mix of products to a diversified set of trade partners. With trade amounting to more than 150 percent of GDP, Vietnam is among the world’s most open economies. The country has rapidly gained world export market share, which has increased from about 0.2 percent in 2000 to close to 1 percent of world exports in 2014. In the first phase of export growth following the economic Doi Moi reforms in the late 1980s to the early 2000s, exports of agricultural products, oil and gas, and apparel were the main export product categories. In the past decade, export growth has been particularly strong in manufacturing of electronics and apparel. As a result, Vietnam’s export product mix has shifted from a high share of agricultural commodities and crude oil to cell phones, other electronics, and garments. At the same time, the agricultural sector has continued to perform well in absolute terms, cementing Vietnam’s strong global position in agricultural products ranging from seafood to rice and coffee. Measures of export diversification show substantial increases in diversification over the past two decades.

Strong FDI inflows in the manufacturing sector have enabled Vietnam’s manufacturing export growth. FDI inflows accelerated in the run-up to Vietnam’s WTO accession in January 2007 from an annual average of $2.5 billion over 2000–05 to an annual average of $8.4 billion over 2008–14. FDI has been increasingly concentrated in manufacturing, with major inflows from Korea, Japan, Singapore, and Taiwan Province of China. Companies such as Intel, Nokia/Microsoft, and Samsung have shifted significant parts of their production to Vietnam over the past decade, and through these investments, Vietnam is embedded in global and Asian supply chains. The FDI sector’s share in Vietnam’s total exports has reached 60 percent. Vietnam’s attractiveness to foreign investors results from a variety of factors, including government policies encouraging FDI, openness to trade, a geographic location near major supply chains, political stability, abundant labor resources, and tax incentives.

China is Vietnam’s most important supplier, accounting for one-third of imports, but FDI from China is limited. Vietnam has a large bilateral trade deficit with China. China is a major supplier of consumption and capital goods and, more recently, has become a source of intermediate goods for final assembly in Vietnam as final production in Vietnam has expanded. Import duty reductions under the ASEAN-China free trade agreements starting in 2015 could help boost bilateral trade between Vietnam and China.

Going forward, TPP and new FTAs present opportunities for further export growth. Among the current TPP signatories, Vietnam—as the economy with the lowest per capita GDP—has unique comparative advantages, particularly in labor-intensive manufacturing. In addition, in 2015 Vietnam concluded FTA negotiations with important trading partners: The European Union who accounts for a fifth of Vietnamese exports, Korea, the largest source of FDI to Vietnam, and the Eurasian Economic Union.

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2Duval and others (2015) use value-added data to show that dependence on Chinese final demand amplifies the international spillovers and synchronizing impact of growth shocks in China. Cheng and others (2016) also use value-added data and look at which Asian countries are benefiting most from the global value chain and how they can increase their participation. The spring 2016 Regional Economic Outlook for Asia and the Pacific contains two chapters on China spillovers—Arslanalp and others (2016), which considers trade and financial spillovers, and Helbling and others (2016), which focuses on trade links and examines spillovers from China on advanced upstream economies as well as on commodity exporters and commodity markets. Other relevant papers include Rafiq (2016) and Dizioli and others (2016), which analyze China’s spillovers to Southeast Asia.

3To narrow the scope of analysis, the paper does not focus on other countries that also will face opportunities and challenges as China changes—Bangladesh, Nepal, and Sri Lanka come to mind, as do a number of countries in Africa and Latin America. The paper also does not focus on trade in services.

4Helbling and others (2016) also analyzes the implications of China’s transformation for commodity exporters and commodity markets more generally.

5FDI was, however, permitted in only certain parts of the country. It was not until 1994 that FDI was permitted in all parts of China.

6Chapter 3 of the October 2015 World Economic Outlook nonetheless finds ambiguous evidence on the claim that the elasticity of trade to real effective exchange rates has fallen.

7Other stylized facts emerged as well. For instance, while countries at all income levels purchased both low-tech and high-tech goods from China, high-tech imports were relatively more important for richer countries, and as a result, China’s exports to advanced economies typically tended to have lower domestic value added than its exports to poorer countries. Also, multinationals tended to rely more heavily on foreign inputs, and thus have a lower domestic value-added ratio, than do domestic Chinese firms (Koopmen, Wang, and Wei 2008, Baldwin and Lopez-Gonzales 2013).

8Hong Kong SAR remains the second-largest export partner of China, but most of this trade is intended for re-export.

9The OECD TiVA database is not the only source of information on value-added ratios. Kee and Tang (2015), for instance, find that the domestic value-added ratio went from 65 percent to 70 percent between 2000 and 2007.

11Processing trade refers to the business activity of importing all, or part of, the required inputs (raw and auxiliary materials, parts and components, accessories, and packaging materials) and re-exporting the finished products after processing or assembly by domestic enterprises. Processing-trade exports tend to have a far higher imported content than regular exports.

12China is now the world’s largest exporter of LCD screens, but it is not clear that these exports are going to a new assembly-hub country. It may be that the goods are being exported to Hong Kong SAR, lightly processed, and then sent back to China to satisfy domestic demand. Even if this is the case, however, we have clear evidence that China is at least producing these sorts of sophisticated, upstream parts.

13It is worth noting that this analysis is all at the level of the country, without any comment on the ownership of the export facilities in question. China’s exports of LCD screens, for instance, may be growing because Korean producers have set up factories in China—in such a case, China’s export success may directly yield Korean income gains, but China also benefits, and it is still valid to say that China, as a country, has succeeded in moving up the value chain. In addition, there are many cases in which Chinese-owned firms have come to dominate sophisticated sectors—Huawei, for instance, now has a larger share of the global smartphone market than LG does. Box 2.1 discusses FDI and ownership issues further.

14Some contend that the difficult demographics could be materially delayed with policy changes such as an increase in the retirement age or a change in the pension policy to reduce an implicit penalty on late retirement.

15A plateauing, or even an exit from some labor-intensive sectors, is more apparent if one examines not export data reported by China, but rather import data from its partners.

16Helbling and others (2016) examine in further detail the implications of changes in China for commodity exporters and commodity markets more generally. One finding is that China’s demand for food and agricultural commodities has grown faster than would have been predicted in recent years.

17Looking directly at consumption imports may understate the impact. Some items that a casual observer would consider consumption items are officially classified as capital goods (for example, telephones—SITC code 764.11—are classified as BEC code 41, which is for capital goods). Moreover, higher consumption could induce higher imports of intermediate goods, which are then domestically assembled into final consumer goods.

18The CLMV also trade heavily with other ASEAN nations, with Thailand playing a particularly important role. These nations too will face important changes as China’s trading patterns transform, and these changes in turn could have important indirect implications for the CLMV. Analysis of these links, however, is not presented in this report.

19Given the limited availability of official trade statistics in Cambodia, Lao P.D.R. and Myanmar, we conduct trade analysis using the gross trade “mirrored” data in the UN Comtrade database (i.e., data reported by trading partners). See OECD 2013a for further details.

20Distance here is measured between two trading countries’ capital cities. While other measures are possible—for example, the distance between geographical centers, or the distance between the most populous cities—Boisso and Ferrantino (1997) suggest that the results should be similar regardless of which measure is employed.

21Against this, there may be increasing scope to supply food and agricultural commodities to China.

22Although those garments could then compete with China’s own exported garments, in practice they are protected through preferential treatment in the US and EU markets.

23Indeed, consumption exports from Vietnam to China have grown substantially in recent years, as have Chinese tourism flows to Southeast Asia.

24Cambodia ranks 139 out of 189 in getting electricity and scores lowest among its Asian peers (Doing Business 2015, World Bank).

25The standard deviation of growth for Cambodia is 3 percent while that of the average Asian LIC is 2.4 percent.